Litigation: 2nd Circuit lends a helping hand to the SEC

In a case that alters the landscape of aider and abettor liability, the 2nd Circuit has just made it easier for the Securities and Exchange Commission (SEC) to civilly prosecute aiders and abettors of securities fraud by clarifying the standard for “substantial assistance.” According to the court’s logic, because the goal of SEC enforcement actions is deterrence, not compensation of a specific injured individual, the more strict proximate cause standard for civil plaintiffs should not be used to create a road bump in the SEC’s path.

As many readers may know, Section 20(e) of the Securities Exchange Act of 1934 allows the SEC, but not private litigants, to bring civil actions against “any person that knowingly provides substantial assistance” to a primary violator of the securities laws. To find a defendant liable as an aider and abettor in a civil enforcement action, the SEC must prove:

1. “The existence of a securities law violation by the primary (as opposed to the aiding and abetting) party”

2. ”Knowledge’ of this violation on the part of the aider and abettor”

3. “‘Substantial assistance’ by the aider and abettor in the achievement of the primary violation.”

- SEC v. Apuzzo

In SEC v. Apuzzo, the SEC alleged that Joseph Apuzzo, the Chief Financial Officer at Terex Corporation, a construction and mining equipment manufacturer, facilitated violations of the federal securities laws by, for example, executing agreements and approving invoices in a “sale-leaseback” scheme designed to allow an equipment rental company to prematurely recognize revenue and inflate profit generated from its sales. Apuzzo moved to dismiss the case on 12(b)(6) grounds, arguing that the SEC had failed to adequately allege that he substantially assisted in a fraud because it didn’t allege his conduct to be the proximate cause of the primary violation. The district court agreed with Apuzzo and dismissed the case, holding that proof of “substantial assistance” required a showing that the aider and abettor proximately caused the harm on which the primary violation was predicated—a showing which the SEC did not make.

The SEC appealed, and on Aug. 8, a three-judge panel, comprised of Judge Jed Rakoff sitting by designation, and Judges Ralph Winter and Reena Raggi, reversed the district court. Applying a test articulated by Learned Hand in 1938, the appellate court held that, to survive the pleadings stage with respect to the “substantial assistance” element, an SEC complaint need only allege that the defendant “in some sort associated himself with the venture, that he participated in it as in something that he wished to bring about, [and] that he [sought] by his action to make it succeed.” Apuzzo (citing United States v.Peoni). Noting that, unlike in the context of civil plaintiff-driven actions, the purpose of an SEC enforcement action is deterrence, the 2nd Circuit articulated a standard for “substantial assistance” that more closely resembles criminal notions of accomplice and conspiracy liability than the tort-based concept of proximate cause.

“Proximate cause,” the court opined, “is the language of private tort actions; it derives from the need of a private plaintiff, seeking compensation, to show that his injury was proximately caused by the defendants’ actions. But, in an enforcement action, civil or criminal, there is no requirement that the government prove injury, because the purpose of such actions is deterrence, not compensation.” The court further wrote that “where, as here, the SEC plausibly alleges a high degree of actual knowledge, this lessens the burden it must meet in alleging substantial assistance.”

The 2nd Circuit, of course, had to acknowledge that “in fairness to the district court, our case law has not always made this distinction with clarity.” That much is certainly true. But it has now, and the implications of the ruling are not insubstantial. Although we’re not likely to see a dramatic uptick in civil enforcement actions, the 2nd Circuit has just made the SEC’s job a lot easier. At the very least, the decision could have a very real and concrete impact on defendants’ ability to obtain early dismissal of aiding and abetting claims.